Private Markets I — PE/VC Fund Economics

Learning objectives

By the end you can:

1. Read a fund's cash-flow schedule end to end (commitment, capital calls (drawdowns), the investment period, distributions, and fund term/extensions) and explain why the resulting cumulative-net-cash-flow curve is shaped like a J (the J-curve) as a mechanical consequence of fees and unrealized cost preceding realized gains, not a signal about fund quality.
2. Define and compute PIC, DPI, RVPI, TVPI, and MOIC precisely, state the Gross vs Net distinction (before vs after fees and carry) that every one of these multiples carries, and explain why a fund's NAV/RVPI is a GP's fair-value mark (ASC 820 / IPEV convention) (an estimate, not cash) while DPI is the only figure that is certain.
3. Compute a fund's IRR and reconcile it to a hand-computed XIRR on the fund's actual, irregularly-dated cash flows, distinguishing this dollar-weighted, cash-flow-based IRR from the time-weighted returns you compute for public portfolios (AA1.03), and state the reinvestment-rate critique of IRR and the IRR-flattering effect of subscription-line financing.
4. Explain vintage-year and selection effects: why a fund's own TVPI mechanically understates true quality in its early years purely from where it sits on the J-curve, and why comparing raw benchmark IRRs/multiples across vintages or across self-reported databases is a common, costly analytical error.
5. Model the full fee schedule: the management fee on committed capital during the investment period, its step-down to a rate on invested/remaining cost thereafter, and its effect on Net vs Gross figures.
6. Build and run both waterfall architectures by hand and in Python, the European (whole-fund) and American (deal-by-deal) distribution waterfalls, including the preferred return (hurdle), the GP catch-up, and the final carry split, and compute a clawback obligation when a deal-by-deal structure has overpaid the GP relative to the whole-fund entitlement.
7. Explain the GP–LP alignment architecture: GP commitment ("skin in the game"), key-person provisions, for-cause vs no-fault-divorce GP removal, most-favored-nation (MFN) clauses, and the ILPA Principles, and connect each mechanism to the specific misalignment it exists to fix.

The duality, stated once (R10). This is the corpus's highest AI-over-trust region for a specific reason: fund economics is compute-heavy (irregular dated cash flows, compounding preferred returns, tiered waterfalls), and every one of those computations is exactly the kind an AI assistant will produce fluently, confidently, and (if a single date, a single tier boundary, or a single compounding convention is off) wrong, with no visible sign of the error. The gated skill is being able to build the schedule and the waterfall yourself, by hand and in Python, and verify any AI-produced version against that by-hand build before a single number leaves your desk (AI0.01's Guardrail applies to every figure in this module).

Prerequisites & connections

Builds on. M6.04 (Behavioral Finance) supplies the investor-psychology lens this module borrows directly: an LP who redeems from, or stops committing to, a manager because a three-year-old fund's TVPI looks weak is running the identical recency-bias/pattern-matching error M6.04 catalogs, except here the "pattern" is mathematically guaranteed to look weak at that stage regardless of the fund's eventual quality (§4.6 makes this precise). M3.10 (Special Situations) is the valuation machinery this module assumes: a GP's fair-value mark on an unrealized portfolio company is a DCF-or-comps valuation with an illiquidity lens, and M3.10's distressed/IBC content is exactly what applies if one of the fund's own portfolio companies lands in default, this module does not re-derive any of that, it names where the mark comes from and moves on. E11.02 (M&A, Deals & Special Situations) owns the deal mechanics, sources-and-uses, purchase accounting, the LBO capital structure (alongside M3.09's LBO model), that a buyout fund's individual investments run on; PW1.02 starts one level above a single deal, at the level of the vehicle that holds many such deals and the LPs who fund it. Two further connections worth holding even though they sit outside this row: M3.01 (Time Value of Money) is the IRR/XIRR foundation this module extends to irregular, multi-event cash-flow schedules, and M3.09's LBO model is precisely what a buyout-style GP is running inside each portfolio company this module treats as a single dated cash flow.